SPY BECOMES SHORT-TERM OVERSOLD -- USING FIBONACCI RETRACEMENTS TO ESTIMATE SUPPORT ZONES -- UTILITIES FIRM AS MARKET TURNS DEFENSIVE -- TREASURIES COULD HOLD KEY TO NEXT MOVE IN STOCKS -- 10-YEAR TREASURY YIELD HOVERS AROUND 2%
SPY BECOMES SHORT-TERM OVERSOLD ... Link for todays video. At this point, Tuesdays sharp decline is viewed as a mini-correction within a bigger uptrend. It is simply one big down day after an 11-week advance. So how far might this correction run? There are many methods to estimate potential support levels or levels that will produce a bounce. Some focus on the very short-term, while others take a longer term outlook. Chart 1 shows the S&P 500 ETF (SPY) with 14-day RSI and 2-day RSI. During strong uptrends, 14-day RSI is expected to trade in a bull zone between 40 and 80. This means the 40-50 area may act as support on a pullback. With Tuesdays decline, RSI dipped below 50 and firmed with todays bounce. Also notice that the mid February lows could offer support at 134.
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Chart 1
The lower indicator window shows 2-period RSI. Larry Connors uses 2-period RSI as part of a trading strategy to look for short-term buying opportunities within a bigger uptrend. First, notice that SPY moved above its 200-day moving average in late December and held above this key level. This is the first requirement for his system. According to Connors, a subsequent dip below 10 signals a short-term oversold condition that could lead to a bounce. 2-period RSI reached 4.35 on yesterdays close, which clearly counts as short-term oversold. Admittedly, looking for a bounce after a 2-3 day decline is very short-term oriented. Such strategies mean chartists need to watch the market quite closely and manage risk. You can read more on this 2-period RSI strategy in our ChartSchool or in his book, Short-Term Trading Strategies that Work
USING FIBONACCI RETRACEMENTS TO ESTIMATE SUPPORT ZONES... Chartists more medium-term or long-term oriented can look for potential support levels a little lower. Chart 2 shows SPY with the Fibonacci Retracements Tool extending from October-March and from late November to March. Sometimes it is difficult to pick the exact advance upon which to base the Fibonacci Retracements Tool. In this case, I am measuring based on two advances and looking for a cluster. Notice that a 38.2% retracement of the October-March advance and a 50% retracement of the November-March advance cluster in the 126-127 area. Also notice that broken resistance levels in the 127-128 area turn into support (yellow area). The 200-day moving average is just below these two support zones, and rising. This means the 200-day may rise to further confirm this support zone in a few weeks. Keep in mind that this is not a hard support zone. Instead, it is a potential reversal area to watch should prices correct this far. Chart 3 shows the Nasdaq 100 ETF (QQQ) with a similar zone in the 59 area.
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Chart 2
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Chart 3
UTILITIES FIRM AS MARKET TURNS DEFENSIVE... Stocks were clobbered on Tuesday, but the Utilities SPDR (XLU) held up rather well and remained within its consolidation. Chart 4 shows XLU peaking at the end of December and falling sharply in January. This steep decline coincided with a sharp advance in the stock market and caused XLU to underperform significantly. Underperformance in a defensive sector makes sense during a broad market advance or in a risk-on environment. In a risk-off environment, money rotates into relatively safety and seeks yield when the broader market is weak. With this in mind, chartists can watch XLU for clues on the broader market. An upside breakout would be bullish for XLU and suggest a more defensive oriented stock market. A downside break would bearish for XLU and suggest that money is moving out of relatively safety.
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Chart 4
TREASURIES COULD HOLD KEY TO NEXT MOVE IN STOCKS... With the exception of Tuesdays sharp decline, stocks have been extraordinarily strong in 2012. Economic reports have also been on the strong side the last few months. Despite a strong stock market and improving economy, treasury bonds refuse to buckle and remain at relatively high levels. This is, of course, because the Fed instituted a zero-interest rate policy until well into 2014. Despite said policy, the Fed is notoriously behind the curve and the treasury market often moves well before the Fed changes its policy stance. Chartists should watch treasury bonds for clues on future Fed policy, the strength of the economy and the direction of the stock market. An upside breakout in treasuries would point to lower interest rates and suggest weakness in the economy, which would in turn be bearish for the stock market. A support break in treasuries would point to higher interest rates and suggest strength in the economy, which would be bullish for stocks. Yes, I think the next significant move in stocks depends on treasury bonds. Chart 5 shows the 7-10 year T-Bond ETF (IEF) advancing to a new 52-week high at the end of January and then consolidating the last 5-6 weeks. A triangle has taken shape with resistance at 105.70 and support at 104.40. Watch these levels for the next directional signal.
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Chart 5
Chart 6 shows the 20+ Year T-Bond ETF (TLT) surging in November-December and falling the last 2-3 months. A falling channel has taken shape with resistance at 119. Admittedly, this looks like a bullish continuation pattern. In other words, a channel breakout would signal a continuation of the prior surge and project a move to new highs. Needless to say, such a breakout would be negative for stocks. Money moving into treasuries is money not available for stocks.
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Chart 6
10-YEAR TREASURY YIELD HOVERS AROUND 2% ... Treasury bonds and treasury yields move inverse to each other. Yields rise when bonds fall and yields fall when bonds rise. Sometimes treasury yields provide a more accurate assessment of treasury bonds than the ETFs, which are based on a basket of treasury bonds. Chart 7 shows the 10-year Treasury Yield ($TNX) oscillating around 2% (20) since mid December. If it were not for the Feds zero interest rates policy, I think the 10-year Treasury Yield would be well above 2.1%. A break above 2.1% would be bearish for the treasury bond ETFs and signal higher yields down the road. Should resistance hold, a break below 1.8% would be bullish for treasury bond ETFs and signal lower yields ahead. Chart 8 shows the 30-year Treasury Yield ($TYX) with support at 3% (30).
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Chart 7
